For many Bulgarians, the International Monetary Fund (IMF) is inextricably linked to the austerity policies that followed the collapse of the country’s banks in 1996 and any advice from the institution is instantly viewed with suspicion.

But with a Budget deficit looming for the first time after 12 years of uninterrupted surpluses and economic growth and the prospect of needing a bailout package –  a possibility trumpeted for months by some analysts abroad – Bulgaria’s Cabinet has invited a Fund mission to review the Government’s economic stimulus plans.

No negotiations concerning a possible bailout package were held during the visit, the IMF mission said on September 21 after concluding its review. What the mission statement offered Bulgaria was the usual dose of warnings, mixed in with moderate praise and an appeal to find a new growth model.

Bulgaria’s economic situation was grim, with domestic demand hit by a sharp drop in capital inflows, which has led to a near-halt of credit growth, while exports have been affected by the recession in Bulgaria’s trading partners, the Fund said in its mission findings summary. Real economic growth in the second quarter of 2009 was 4.9 per cent lower than a year earlier and the IMF forecast a 6.5 per cent decline for the year and 2.5 per cent in 2010.

Nevertheless, the crisis brought some hidden blessings with it. Even as exports and manufacturing production declined sharply, imports have dropped even more, and the current account deficit has halved. Year-on-year inflation has declined from 15 per cent in June 2008 to 1.3 per cent in August 2009.

"Bulgaria started the downturn with considerable public sector buffers, including a large fiscal surplus and sizeable reserves in the fiscal reserve account," the Fund said. "These buffers were important given its large private sector vulnerabilities – after years of large capital inflows, private sector external debt had increased to about 100 percent of gross domestic product (GDP)."

Capital inflows fuelling consumption generated robust tax revenue in previous years, allowing Bulgaria to maintain a Budget surplus even as government spending increased. But the revenue boom is now over and unless the Cabinet stemmed the spending increase, the fiscal surplus could soon turn into a large deficit, the IMF mission said.

Budget woes in focus
The Fund criticised, in less than a straightforward way, the previous cabinet of prime minister Sergei Stanishev, saying that during the first seven months of 2009, fiscal policy had not adjusted to the new economic environment. The socialist-led tripartite coalition was ousted from power at the July 5 general elections, but Stanishev’s government remained in office until the end of the month, when Boiko Borissov’s Cabinet took over.

With revenue declining by 10 per cent compared to the first seven months of 2008 and spending increasing by 24 per cent, Bulgaria recorded a 0.6 per cent Budget deficit in January-July, as opposed to a 6.3 per cent surplus for the same period last year. "Without corrective measures, the 2009 fiscal deficit could have increased to more than 3.5 per cent of GDP," the IMF said.

The Fund praised the new Government’s commitment to a tighter fiscal policy, saying that "the renewed focus on fiscal discipline is welcome and necessary. Given its large private sector vulnerabilities, and the constraints imposed by the currency board, Bulgaria can ill afford to run large fiscal deficits".

The thrust of the Cabinet’s efforts will be to increase revenue by raising revenue compliance, rooting out VAT fraud and increases in excise duties, while simultaneously downsizing public administration, freezing public wages and pensions until the economy recovers, reducing Budget funding for investment projects and shifting financing of public investment towards higher absorption of European Union funds.

Bulgaria’s Finance Minister Simeon Dyankov has said that Bulgaria would aim for balanced Budgets in 2009 and 2010, a goal that the IMF said would be "very challenging".
"On the revenue side, there are risks that the gains from increased tax compliance may fall short of expectations, while on the expenditure side, the envisaged cuts will require strong spending discipline. Given these risks, it is well possible that a small fiscal deficit could emerge in 2009, and a deficit of two per cent of GDP in 2010, and higher deficits are possible if the economy were to contract more than expected," the IMF said.

Dyankov, speaking to reporters on the same day after the Fund’s experts presented their findings, said that it was a normal reaction for the IMF to adopt a more conservative forecast for the Budget deficit.

The Cabinet’s efforts to curb the excessive deficit, which could have mounted another obstacle on Bulgaria’s road to adopting the euro, were well-received by the IMF, Dyankov said. "This year will be a struggle, but our forecast for this year and the next is to achieve a balanced Budget. The IMF is more conservative because crises that last longer than a year are usually accompanied by a worsening of public finances," Dyankov said.

To ease the pressure on the Budget, Bulgaria needed to vigorously implement its planned measures, reducing spending permanently, the Fund said.

"This could best be achieved by targeted cuts rather than across the board spending reductions. Enhanced administrative capacity will help in creating an appropriate environment for businesses and boost potential growth, while raising the absorption of EU funds. Plans to cut the social security contribution rate in 2010 and over the medium term should be considered only within the framework of a comprehensive pension reform, aiming at ensuring the sustainability of the pension system," the IMF mission said.